Enterprise Resource Planning (ERP) is the foundation of every manufacturing company, as it eases out the process of planning, allocating, tracking the inventory and raw material and distribution.
It is imperative to plan the ERP system that can yield productivity and increase automation in the manufacturing process.
You should forecast and make sure that the benefits of the ERP outweigh the system costs otherwise, do not invest your hard-earned cash in this.
Understanding the ROI
Return on Investment (ROI) is one of the metrics on the surface used to measure the returns on any project and to compare these with the other potential investment.
It is calculated by adding up the expected project returns minus expected ERP cost. Then, divide the result by the expected ERP cost, and the quotient is the ERP ROI. The larger the quotient, the better the investment is as compared to other potential investments.
It is difficult to calculate the ROI as different individual and department might define and interpret the cost and return differently. So, a finance department should ensure that all the cost calculation and collection is consistent across the department.
There are two factors, time and risk that have considerable impacts on the ROI calculation but are not included in the ROI calculation.
For instance, a business has two options for ERP investment, giving the same amount of ROI. Let us assume that “A” offers higher cost along with a longer payback and “B” system’s cost is spread over time and yields returns at the beginning.
The second option is more viable than the first one as cost and revenue in the future is less predictable and hence riskier.
How to accurately predict ERP costs?
There are some costs like software licence and hardware purchases that are apparent as their price does not fluctuate. But there are a few areas, which require more efforts and consideration to calculate. Mostly, there are five types of costs:
- Initial cost
It includes the initial cost of buying the ERP software from the vendor. You should mention all the necessary specifications in the purchasing module. As a vendor will not give a second thought before making the software, so give all the necessary details to him.
There are two main types of deployment model for ERP:
A) On-premise ERPs purchase through a one-off license fee and hosted on the company’s server. As per this model, a company needs to upgrade its hardware to run its ERP system. It is another cost that you should include in ROI cost calculations.
B) Cloud ERPs are hosted on the vendor’s server and accessed through the internet. It is charged on a per-user-per-month model as long as you access the system, which will impact the final ROI figure.
In this system, you don’t need to upgrade the hardware.
- Consultancy Costs
To set up an ERP system, you will need some guidance and assistance from consultants along with internal resources. Try to estimate these costs as precisely as possible, as many times they exceed the overall project budget. Define the scope-of-work and workforce-hours requirement of the project, and document them in writing. Finally, get that approved by the project head.
- Maintenance Cost
It includes the expenditure related to the periodic software upgrade and helps desk support agreement with the vendor. To make it simple, calculate the cost over the expected life of ERP or at least for seven years.
- User Cost
User cost includes the cost incurred on training to implement the ERP system. You should also include factors like the cost of bringing extra workforce in overtime for training.
Mention the depreciation cost, as over the time efficiency of machinery or software also decreases.
Forecast and Identifying ERP Return
Returns are one of the main reasons for establishing an ERP system. In other words, how will ERP help in reducing your operational cost?
To find these answers, you need to conduct a detailed analysis of the input variables for calculating ERP ROI.
- Assign Returns to Requirement
Communicate with your managers, executives and users to collect and document the reasons as to why you require the tools present in ERP. After this, place the monetary values next to each need. For example, what is the direct advantage of ERP? Will your company be able to manufacture the same product faster or not?
- Predict the Potential Return
You should maintain a balance between cost and the return of the ERP system. In other words, the main motto is to overcome the operational cost of setting up an ERP system, whether the ERP system is yielding enough profit or not. For example, a company sets up the ERP software for data entry that now requires two persons unlike, before when the company needed five persons for the same task. Here, productivity will not increase, but the operational cost of the company will decrease, which will lead to higher ROI.
Analyse the Data
Selecting and assessing the ERP system produces a vast amount of data. To precisely and accurately collect the ERP ROI, it is crucial to connect the dots to dissect all the critical information and data. You need to coordinate with the concerned department related to the ERP system to ensure all the inputs are valid and relevant. Your finance department should crosscheck to ensure all the evaluation of cost and revenue is consistent. It should act objectively to resolve any departmental biases.
Analyse Final ERP ROI Figures
By now, you have completed all the daunting tasks of calculating ERP ROI. You have access to potential cost and return of the ERP system.
Now, perform the final step of calculating ERP:
Is ERP a Wise Investment Choice?
ERP project is not the only opportunity to invest the money, as your production team might need a new automated assembly line, or distribution team wants new software for the supply chain. Perform the same test and analysis on the costs and return on the other areas of a potential investment.
Delve Into Positive ROI Figures
Analysis of ROI is the time to bring the elements about risk and timing into play. Take out time to study ERP ROI in the context of cost risks and return schedules. If that ERP system is still the best options after these analyses, it’s time to commence the selection of an ERP system.
With numerous advantage, it is impractical to avoid implementing an ERP system. Therefore, implement a robust ERP system to save undesirable operational cost and increase productivity and efficiency of your business. Making an early investment in setting up of an ERP system will offer ROI sooner. It will make your business structure more organized, remove unnecessary processes and manual data entry work, decrease errors and duplicate entries, which eventually bestow higher profitability and ROI.